Family Offices frequently acquire interests in private funds as part of the family office asset allocation process. Private funds have to be certain of the validity of their ability to rely on an exclusion from the definition of “investment company.” The Family Office Rule under the Investment Advisers Act has a detailed definition of “family member” for purposes of that exemption. In general, a person is a “family member” if he is a lineal descendant of a common ancestor, or a spouse or child of a lineal descendant. There is also a definition of “family client” that includes every possible trust, charitable organization, or ownership situation to which the family office could give investment advice. But the Investment Company Act also defines “family,” differently, in the two most commonly used exclusions from the definition of “investment company.”
Definition of “Accredited Investor”
Specifically, all private funds must offer their interests in a manner that is not a public offering. The most common exemption under the Securities Act of 1933 is so-called Regulation D. Rule 501(a) in Regulation D defines to the term “accredited investor” to include:
- a natural person whose individual net worth, or joint net worth with a spouse, exceeds $1,000,000 (without taking into account his residence and related indebtedness;
- a natural person who had an individual income in excess of $200,000 in each of the two most recent years (or joint income with a spouse in excess of $300,000) and has a reasonable expectation of reaching the same income level in the current year;
- any trust with total assets in excess of $5,000,000 and not formed for the specific purpose of purchasing the securities being offered, and whose decision is being made by a sophisticated investor; or
- an entity in which all equity owners are accredited investors.
A younger member of a family might be able to invest through a trust whose trustor was a sophisticated investor, but are otherwise unlikely to be an accredited investor. A charitable organization with less than $5 million in total assets would not be an accredited investor even if the sophisticated investor behind it was herself quite wealthy.
Definition of “Qualified Purchaser”
For those private funds that intend to rely on Section 3(c)(7), the offeree must not only be an accredited investor under the 1933 Act, but also be a “qualified purchaser” under the Investment Company Act. Section 2(a)(51)(A) of the Investment Company Act defines the term “qualified purchaser” to mean:
- a natural person who owns not less than $5 million of investments;
- a company that owns not less than $5 million in investments and that is owned by two or more natural persons who are related as siblings or spouse (including former spouses) or direct lineal descendants by birth or adoption, spouses and estates of such persons, or charitable organizations or trusts established by or for the benefit of such persons;
- any “trust” not identified in the bullet point immediately above, not formed for the purpose of making the investment, and as to which each person authorized to make decisions and each settlor or contributor of assets is himself a qualified person; or
- any institutional investor who, in the aggregate, owns and invests on a discretionary basis not less than $25 million
So, the charitable foundation in the previous example with less than $5 million in investments, which was not an accredited investor, may nevertheless be a qualified purchaser under the third bullet point if established and managed by a qualified person. Similarly, a parent exercising investment discretion over a trust for the benefit of his child or children could qualify the trust as a “company” identified in the second bullet point above even though the child could not qualify as an accredited investor in his own right.
The point is that the different definitions of “family” in each of these three statutory settings can be a trap for the unwary private fund attempting to sell interests to persons in a wealthy family, and thus jeopardize its own status. It is possible to navigate this terrain, but the world would be more hospitable to investments in private funds by family offices if there were consistent definitions of “family” in all three contexts.